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Fixed income

Why Brexit negotiations could lead to more sterling volatility

The fall in the British pound this week to 31 year lows came after clues emerged from the Conservative Party annual conference about how the UK government will approach Brexit negotiations.

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Mark Nash, head of global bonds, Old Mutual Global Investors, comments on the effects of Brexit negotiations on the pound

The fall in the British pound this week to 31 year lows came after clues emerged from the Conservative Party annual conference about how the UK government will approach Brexit negotiations. To date it has been unclear what kind of separation the government would seek in their negotiations with Europe, and both ‘soft’ and ‘hard’ Brexit options have had their supporters within the Conservative Party.

The details of exactly what the UK government wants are still not completely clear, but various speeches and interviews have shed more light on the question. What we know for certain is the timing: Article 50 is to be invoked by the end of March 2017.

What we think we now know is that the British government is seeking full control over law making, immigration and the ability to initiate trade deals with third party countries outside of the EU. In short, there appears more hard-line approach to the Brexit negotiations than many were expecting.

The British pound fell on these declarations for several reasons.

Firstly and least surprisingly, there appears very little leeway on the issue of immigration with ‘full’ control of UK borders non-negotiable. Considering this demand, the UK’s membership of the Single Market appears very unlikely, as free movement of peoples is an essential requirement for access.

Secondly, the desire to be able to instigate trade deals mean membership of the Customs Union also looks unlikely. The Customs Union allows tariff free trading with EU member states but trade deals with third party countries must be written en bloc.

Finally, the timing issue opens up complications, as Article 50 is likely to be triggered ahead of French and German elections. The bargaining posture of European politicians is likely to be nationalistic and unlikely to favour compromise. The process will, at best, be slow. Uncertainly will probably be great, and, at worst, no deal will be reached at all. Full withdrawal from Single Market and the Customs Union, with no bilateral deal could badly damage UK growth.

The ‘hard’ Brexit option, pushed by the three ‘Brexiteers’ in the cabinet, appears to be in the ascendant. If it hard Brexit prevails, prospects for growth are more negative, as the UK’s valuable financial sector might not be prioritised in the negotiations. The International Monetary Fund (IMF) has predicted that the UK will grow comparatively quickly this year, and the weaker pound may be expected to give exports a boost; but the IMF also reduced its medium term growth forecasts for the UK. Given the lines the government has drawn out, the outcome for the UK’s access to the EU looks likely to be very damaging for UK exports in the long term.

For these reasons, the outlook for sterling is highly uncertain and volatility is likely, in our view, in coming months and years.

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